Capital dividends are a special type of dividend that Canadian-controlled private corporations ( CCPC ) can pay to their shareholders on a tax-free basis. The Canada Revenue Agency ( CRA ) uses the capital dividend account ( CDA ) to keep track of the capital dividends that are available to shareholders on a tax-free basis. Capital dividends were created to improve the integration in the Canadian tax system, specifically, capital gains incurred within a corporation will have a similar impact on shareholders as if the shareholders earned the capital gains at a personal level. The tax law relating to capital dividends is complex and our CPA – CA accounting firm based in Edmonton should be consulted if you need further information or wish to claim these types of dividends as we often deal with income tax-related advice to our clients. In this blog post, we will address the most common types of transactions that impact the CDA balance. Our next blog post will include information on less common transactions when tax-free capital dividends can be paid, and additional CDA considerations.
The most common way to increase the CDA balance is through the gain on the sale of capital property (stocks, land, bonds, etc.). A capital gain occurs when the proceeds received on the sale of capital property are higher than the cost of the property, taking into consideration any costs relating to the sale, such as broker and legal fees. Only 50% of a capital gain is added to the CDA balance, which represents the non-taxable portion of the gain. The other 50% of the gain is considered taxable and is included in taxable income for the year. See Year 1 in the example below.
It is important to note that, inversely, losses on the disposal of capital property can decrease the CDA balance. 50% of the capital loss is netted against the capital gain additions and can reduce the CDA balance. Losses on a capital property cannot create a negative CDA balance; rather, the non-deductible portion of the losses is accrued until there are enough non-taxable portions of the capital gains to offset the losses. See Year 2 in the example below.
For the taxable portion of the capital losses, the remaining 50% of the taxable capital loss is applied to the current year’s taxable capital gains. If there are no taxable capital gains to apply the taxable capital loss to, the taxable capital losses can be carried forward for future use or carried back 3 years to set against taxable capital gains.
Sales of depreciable capital assets can be more complicated from a CDA perspective as, more often than not, the depreciable property does not increase in value and, therefore, there is normally no capital gain or loss. In those rare cases where the depreciable property does increase in value, complex rules come into play to ensure the correct capital gain versus recapture on depreciation is calculated correctly. As these issues are complex, taxpayers should consult with their tax accountant, preferably one that has a CPA (Chartered Professional Accountant) or CA (Chartered Accountant) designation. Our CPA–CA accounting firm based in Edmonton is highly experienced in income tax matters and would be pleased to assist you in these matters.
For our example, please consider that the corporation is owned by a single individual shareholder, had no other activity for each year, and that the CDA balance starts at zero in Year 1.
A stock with a cost base of $100,000 was sold for $500,000, resulting in a capital gain of $400,000. 50% of the capital gain is included in income for tax purposes, and the other 50% of the capital gain is allocated to the CDA balance. The taxable income for the year is $200,000. The closing CDA balance for the year is $200,000. The corporation can pay a $200,000 capital dividend to its shareholder without the shareholder having to pay personal taxes. In our example, the corporation does not pay a capital dividend to its shareholders in Year 1.
Land with a cost base of $600,000 was sold for $100,000, resulting in a capital loss of $500,000. Of the $250,000 taxable loss, $200,000 would be carried back to Year 1 and the remaining $50,000 taxable capital loss would be carried forward. The other 50% of the capital loss is allocated to the CDA balance. There would be no taxable income in Year 2 and the CDA balance would be nil as losses on a capital property do not create a negative CDA balance. There is, however, $50,000 in losses accrued ($200,000 gain from Year 1 less $250,000 loss in Year 2) that needs to be offset to bring the CDA balance above nil.
Our experienced and professional team at Filing Taxes is here to set you on the right path considering your personal business situation. Feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step towards proper management of your finances.
Disclaimer: The information provided on this page is intended to provide general information. The information does not consider your personal situation and is not intended to be used without consultation from accounting and financial professionals. Salman Rundhawa and Filing Taxes will not be held liable for any problems that arise from the usage of the information provided on this page.